Why You Shouldn’t Make a Big Down Payment On Your First Home

For decades, it was one of the few hard-and-fast rules when purchasing a home: Put 20% down. A hefty down payment would help you build up equity faster, and make sure your mortgage was affordable.

Times change. A new study from the National Association of Realtors underscores the fact that the 20% mark is far more myth than reality. Over the past three years, the median down payment for a first time homebuyer has been just 6%. It’s higher for those buying their second or third home—the average repeat homebuyer now puts 14% down. But that’s still a dramatic drop from an average of 23% back in 1989. And, in fact, when asked what would be considered a fair down payment, 70% of respondents to an NAR survey said 10%.

The shrinkage of the average down payment is influenced in part by the fact that real estate prices risen far faster than incomes, particularly in and around coastal cities. It’s a concerning trend, especially considering the prevalence of zero-down-payment mortgages that proliferated in the market prior to the last recession, and that worsened the effects of the crash.

But for households in good financial shape, paying less than 20% is not nearly as worrisome as one might think. In fact, it can free up funds for retirement savings and other important goals in ways that can make you look smart down the road.

For starters, the fact that interest rates remain historically very cheap mean that the costs of carrying a bigger mortgage aren’t as painful as they might have been in a different era.

Of course, a smaller down payment means that you have to pay private mortgage insurance (PMI) until you work your way up to having 20% equity. PMI can run 0.5% to 1% of the entire cost of the loan—and in one sense, that can cost you some opportunities. Take a $300,000 home that has a 30-year fixed mortgage of 4% on a loan of $270,000. If you put 10% down, you’ll owe approximately $121 a month in PMI insurance. If you were putting that money in a low-cost index fund instead, you would have over $14,000 in a retirement account after seven years, assuming historical returns.

On the other hand, you could weigh that against the opportunity – and reduction of money related stress – that come with a lower down payment. Say you saved $60,000 for a $300,000 home purchase, but opted to put only 10% down, or $30,000. Now you have $30,000 sitting comfortably in your savings account. According to the NAR, buyers of a brand new home spend $10,601 on appliances, furnishings or repairs in the first year after purchase. Buyers of existing homes spend $8,233 in that first year. You could spend that money, and still have around $20,000 to park immediately in your retirement savings.

You could also put that $20,000 extra into a bathroom remodel or a kitchen repair, either of which could help you build equity in your home if it raised your home's overall value. That could enable you to wipe the PMI off your mortgage bill more quickly—and, eventually, you’ll have more cash flow to feed into that nest egg.